Did Miserable May Light the Way For a Sunny Summer?

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Investors can be forgiven for a little deja vu: In the month of the Flash Crash, wild swings in volatility and incessant talk about risks to the entire financial system, May seemed like a trip back to the bad old days.

The wild and crazy month saw the market rise or fall more than 1.5 percent on nearly half the trading sessions. Major indexes put together their worst May since 1940, and the view from the playing field looked even worse.

"The S&P 500's rollercoaster ride this month is reminiscent of the Cyclone on Coney Island," said Mike O'Rourke, chief strategist at BTIG in New York, in his morning note. "If you ever rode the Cyclone, you know that the truly scary part of the ride was not how high or fast the coaster went, but the fear that it would fall apart at any moment."

Fear, indeed, and the aftermath had analysts worried that the ghost of 2008 was reappearing and fixing to make the summer just a continuation of the "sell in May and go away" strategy.

Investors flocked from the market during the month and particularly in the past week, though some pros think the move will only be temporary and set up for a summer rally.

Equity fund outflows totaled a staggering $16.7 billion in the week ended May 26, nearly four times the previous week's totals, according to Lipper data, which showed money market inflows at $8.205 billion.

Cash on the sidelines, measured by money market funds, increased to $2.849 trillion, a gain of $4.92 billion, according to the Investment Company Institute.

Some blamed the "sell in May" chestnut for the selloff; others saw the European debt contagion as the culprit, while still others looked back to the May 6 Flash Crash, when the Dow lost nearly 1,000 points in less than an hour before rebounding, as a piercing blow to investor confidence in the markets.

"The action since May 6 has been a digestion of the Flash Crash," said Paul Schatz, president of Heritage Capital. "It has taken so much positive sentiment, so much bullishness from the late March and April, wiping it away with a sledgehammer for a couple of weeks."

Perhaps more interesting, though, is that Schatz and others think the May washout actually may be prelude for a rebound.

Whether the rebound lasts is another question, but for now strategists see the move of the stocks into correction territory—defined as 10 percent drop—as merely a natural reaction to the more than 70 percent rally in the previous 14 months.

"If you want a correction you're going to get one," said Linda Duessel, equity market strategist at Federated Investors in Pittsburgh. "We were well overbought. Sentiment measures were getting too high. We were overdue for a correction. It was all in line."

Duessel is sticking to her projection of 1,350 on the S&P by year's end, though she acknowledged that investors have a right to be concerned about the Flash Crash and the mystery that continues to surround the stunning event.

"The event itself is worthy (of concern) but I don't hear many people talking about it," she said. "We should worry about that and why we haven't figured it out."

The market finds itself entering a normally pretty easy time for investors. June and August are usually about average, but July tops the rest of the calendar for stock performance.

Sam Stovall, S&P's chief market strategist, said a "summer sprint" could well be in the cards, and at the least believes worries that the market reverting to financial crisis mode is unlikely.

"We still believe this correction will not become a new bear market as, unlike 2008, the world is emerging from recession, not heading into it, and S&P 500 (earnings per share) growth estimates remain steadfast," Stovall said in a research note.

Still, fear pervades as the CBOE Volatility Index hovers around 30, even venturing above 40 a few times during the month and the market shows other troubling signs.

The New York Stock Exchange had to invoke its Rule 48 four times in May because volatility prevented a smooth market opening for certain stocks. Rule 48 allows the exchange to suspend a rule requiring market makers to show premarket prices.

Also, volume has been significantly more pronounced during down days, and fund flows show confidence remains elusive.

"The everyday investor needs to hear that stocks are going up and that they're going to stay up," said Bob Iaccino, chief market strategist at LotusBrokerage.com. "Every time we have these volatile moves (it's) great for traders but it really isn't convincing investors to put more into (their) 401(k) and get us back that naturally upward bias that equities have had for the last 20 years." (See video)

Indeed, traders continue to hold great sway over the markets compared to the retail investor.

Dan Aaronson, partner at Continental Capital Advisors in New York, thinks it will be traders who will take the market up over the summer now that the correction has cheapened up the market.

While he remains generally pessimistic about stocks, the summer could provide some opportunity.

"The fast money is going to try to take advantage of that pessimism and take these stocks up," he said. "You've got people who have raised cash who are probably flat to down 5 percent this year. Stock trader-types want to put money to work, I'm sure of it."